Matteo Maggiori and Jesse Schreger on Geoeconomics and its Policy Implications

Matteo Maggiori is a professor of finance at Stanford University and a returning guest to the podcast, and Jesse Schreger is an associate professor of economics at Columbia University. Matteo and Jesse, along with Christopher Clayton, have recently authored a paper titled, *A Framework for Geoeconomics,* and they join David on Macro Musings to discuss it. Specifically, Matteo, Jesse, and David also discuss the basics, core concepts, and real world examples of geoeconomics, the key elements of a global hegemon, the future of the discipline, and a lot more.

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Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Matteo and Jesse, welcome to the show.

Matteo Maggiori: Thanks for having us, David.

Beckworth: It's great to have you on, a real delight. Matteo, you joined us, I believe, back in 2021, the first time. I was looking… it was in April, which was right during the thick of the pandemic. We were locked up in our rooms, but we had these conversations. I encourage the listeners to go back and check out that episode because we talked about your work on global capital allocation. You track down all of these different places where assets are being stored, better measures of that. Also, you had some interesting work we talked about on the international monetary system. You had a paper with the late Emmanuel Farhi, which I really love. I still use that paper, and I mention it a lot on this podcast, because one of the things that you show in this paper, it's not the only thing, is how a hegemon monetary power, in some ways, can be more stabilizing than if you had multiple reserve currencies around the world.

Beckworth: I think it was the Nurkse instability claim. It's very interesting. I bring that up, but I think we might invoke it later when we talk about hegemons in your work. I bring that up because I have guests sometimes and people who worry about the growth of shadow banking and the global dollar market and it's just out of control. I ask the question, what's the true counterfactual? What's the true alternative? Is it another system where shadow banking is pulled back, global dollar markets are pulled back, but less stable? That's, I think, the right question to ask, and your paper does that, so I really love that paper. Today, we're going to focus on a new paper that the two of you, plus your co-author, have put out [on] geoeconomics. Let me just start with a very basic question. What is geoeconomics?

Defining Geoeconomics and the Influence of Albert Hirschman

Maggiori: The way we're thinking about it is, countries have existing trade and finance relationships that they can use to get other countries or other firms to do things for them, either for economic means… for example, you might want to prevent foreigners from expropriating you, or you might want to have access to a particular market or to achieve geopolitical goals. You might want to have a particular treaty signed. Or, for example, you might want to ask European firms, if you're the U.S., not to use some 5G technology from China. It's using, essentially, the power that comes from the current economic relationships to achieve these goals. It's something that now that everybody's talking about because we see many examples out there in the real world. But at some level, it's also something that has a long history. Countries have done it for centuries. In some sense, almost the definition of being one of these big, great powers is the ability to do this on a vast scale.

Beckworth: Yes, so in your paper, you define it as countries using economic strength from existing financial and trade relationships to achieve geopolitical and economic goals. You also call it a form of soft power. What was interesting is, I read this paper and it was pointed out to me by some other folks that you guys engage a lot with the political science literature, the international relations literature. I want to mention just a few, gentlemen, just so we can kick this off and highlight their work as it contributes to yours and how it motivates your work. One individual you cite is Albert Hirschman, 1945, a very famous book, National Power and the Structure of Foreign Trade. He was an economist, but he wrote about this very issue. Now, was he a big inspiration or motivation for what you're doing?

Maggiori: Yes, he was a huge inspiration. In general, he's a very inspiring character. We can talk more about other aspects of his life, but for the confines of this paper, really, it's the ‘45 book and also the book that he writes in ’58, are quite inspiring. He was thinking about, particularly Germany, using its economic might and his economic relationships with Eastern Europe and Italy before World War II. It was just more generally thinking through this idea that if I have multiple relationships with you in trade or in finance, I might have some power over you by, for example, threatening to shut them down in multiple dimensions if you don't do something that I would like you to do. I very much think of our work as trying to provide a fully-fledged modern foundation for many of these ideas. Very often it happens that there are topics that we think are very important, and, for a while, we just really can't get the tools to work and sometimes it's difficult to analyze them formally. Then, a number of years later, you get some clarity in your head and you find ways to make it precise and provide some further length to the arguments. They're very much inspired by his work.

Beckworth: Let's talk a little bit about him. We'll come back to the other people that you cite, a few of them, at least, but you mentioned he's an interesting character. Maybe walk us through his history. I think, probably, most listeners who are economists will recognize the Herfindahl-Hirschman Index about market share, market power, but he's much broader than that. Is that right?

Maggiori: I'm certainly not an expert. Actually, I just bought his biography online. I did look him up like anybody that you admire intellectually, you always look them up. He's certainly one where it's easy to get amazed by his life contributions, both in academia and outside. I'll mention a few that I know of. He was pretty involved in getting Jews out of occupied France and Spain during the war. It was part of the program that, particularly for artists and scientists, was attracting them to the United States. And there’s actually a Netflix show out these days where he shows up as one of the characters, so that was certainly pretty interesting. The other thing that was interesting for me privately, was that at UC Berkeley, when he wrote the book that we mentioned in ’45, it's actually printed by the UC Berkeley Press.

Maggiori: When I had to buy the reprint, I noticed that. I was having lunch with my former advisor, [inaudible] from Berkeley this Saturday, and we were discussing his history at Berkeley and how he navigated U.S. academia, so that was certainly pretty interesting. The other big contribution, of course, that he had, is a second book I mentioned, which is about 10 years later. He was instrumental in thinking through links in the economy across multiple firms, so forward and backward linkages, which then became central to network theory, particularly as applied to production functions. So that one originated the whole idea of structural development and the idea that you could bootstrap countries out of poverty, which again, plays a role in the work that we do today, particularly in the input-output linkages in our paper. So, it's pretty fascinating.

Beckworth: I had to go look him up too, because I was intrigued by the work that you cited and other people who have mentioned him. You mentioned he helped Jews escape from occupied France, academics, intellectuals. I read he also fought in the Spanish Civil War. He was at the London School of Economics working on his dissertation and he took time off to go fight in the Spanish Civil War. Then, in the latter part of World War II, he actually was in the U.S. Army and worked for the early version of the CIA. He was overseas, deployed, and then later, he was involved in the Nuremberg trials as a translator and then came back, was an academic, and worked for the Board of Governors as well, so a very rich life. And I bring all of that up and I highlight it because it really informed his thinking. He thought broadly about what you call geoeconomics, and what I've been told is that he made this big contribution, but economists as a whole, we lost interest or focus on the geopolitical power issues until recently. Do you think that's a fair assessment of the profession?

Maggiori: Yes. The way it often happens in our field is we have some ideas that we think are very important and potentially very interesting, but sometimes it's difficult to formalize them, to get the depth and the tools that we're used to, to work in those dimensions, and they stay on the periphery for a while. Then at some point, some clarity emerges, and we figure out how to tackle them, and that generally adds a lot of value but so did the original ideas. I suspect that this one is one of those. There's certainly many other examples of this. I think Paul Krugman had some discussions about this, particularly about Hirschman's work in structural development, and I'm very sympathetic to that point of view. It has certainly happened in my own work that sometimes I go back to these old ideas and find new ways to think about them or formalize them. I find it very interesting.

Jesse Schreger: I think in this case, at least when we were looking around the world, you could increasingly see times when the US or China, or actually other countries, were pursuing what we would openly call geoeconomics, but then once you start looking at the topic, you can actually see that, as you go back, countries have always been doing this, and so there's a sense in which now it may be more out in the open and more explicit, but I think it's not new to history.

Maggiori: I would say also, just to be clear, since his work, particularly in political science, has been extremely influential work on these ideas, throughout the last 70 years. That has also been incredibly useful to us in terms of thinking through these topics and figuring out what other fields are looking at this, particularly international relations. I find it fascinating.

Beckworth: I'll encourage listeners to go check out the paper. We'll provide the link and look at all of the literature review you provide from the political scientists. We want to acknowledge them because we are often accused in the economics profession of being in the silo, not looking outside of it at other fields that have contributed. Just a few citations here I want to mention, because I'm familiar with them, but Henry Farrell, Abraham Newman, and Daniel Drezner have done some recent work on this issue. The term, probably some of our listeners have seen or heard before, is “weaponized interdependence”. That's something that I've seen cited in the popular press as well, but it's great that you do all of this and you've covered it. I'll plug one other piece that's on this, and this was actually a previous guest, Dan McDowell. He has a book called Bucking the Buck: U.S. Financial Sanctions and International Backlash Against the Dollar. I think it touches on what you guys are doing here. I'm going to come back to it later when we talk about some practical examples of what you're doing.

Schreger: Actually, just one thing I'd add to that. First, we got a ton from reading the political science literature, as you mentioned, and you mentioned the work of Dan Drezner, as well as the Farrell and Newman work, on weaponized interdependence. At least for us, one of the resources I found incredibly helpful as an economist looking at these issues was actually, Dan Drezner put together a pretty incredible syllabus of his course on economic statecraft that I've, at least, been treating as really a fantastic resource to engage with the work that's been done in political science. Actually, a lot of the references you mentioned are also included there. It's a great starting point.

Beckworth: We'll provide a link to that in the show notes, so thanks for bringing that up. How do you guys unpack this? How do you approach this issue? Geoeconomics, we've defined it already. You're economists, obviously you're going to use a model. Walk us through how you set up this problem and think about it.

Setting Up the Geoeconomics Model: The Global Hegemon

Maggiori: I think of two broad things. One is the state. What is this power? You mentioned before that this is a form of soft power. I wanted to think about it as in between two extremes. One extreme is the very blunt threat of going to war. You don't do what I say, I can invade your country or I'll send the Navy to blockade your ports. This is not about that. At the other end of the extreme is what economists call complete contracting. It's a world where we can contract on all sorts of features. The contracts are fully enforceable and there is nothing left to bargain over in terms of power. The idea of geoeconomics is somewhere in the middle. It's in those areas where, either because the contracts are incomplete, or there are some things that we just can't enforce. I would like to build a mine in Africa, but it's very clear that the moment I build it, it might get expropriated, or because things that I'm asking you to do aren't things that normally I would like to put into a contract.

Maggiori: For example, I'm China. I might ask you about not hosting the Dalai Lama, or I might ask you about something… I don't want you to recognize some parts of Taiwan's activities. Those are generally not things that we might want to stipulate in a contract, but they're certainly things that we can bargain over. The main question was, why do I have any power over you? The way we started thinking about it is, countries tend to have, or firms, multiple economic relationships. Let me make a trivial example. I might be providing loans to your sovereign, but I might also have firms that either sell manufacturing goods in the country or might operate the mine. I don't want the mine to be expropriated, and I like the loans to be repaid. Normally, each of them might be hard to enforce in isolation, but by threatening you with the joint withdrawal of both activities, I will never lend to you again, or I will never export to you again, should you either default on the loan, or expropriate my mine, or take away the goods that I sent you in trade. That joint threat is very powerful. In some sense, it's giving you high power incentives to behave well with me, because there are so many things that I can threaten you with.

Maggiori: Now, if you scale it up at a much bigger level, think of the threat of shutting down access to financial markets, or to the dollar if I'm the U.S. I can tell you that you can't access the payment system, you're not going to be able to clear your dollar balances in the U.S. That's a very powerful threat across many activities. That's a stick, in some sense. That's what I threaten you with. There's another part, though, which is, what do I use it for? There, we ended up relying on input-output linkages. It's the idea that there are many relationships across the world, and there's all sorts of network amplifications. What I might ask you comes in many different forms. For example, the simplest one is, I just ask you for monetary benefits. I want to sell the goods to you at a markup, or I want to lend, but at a higher interest rate. But in general, I might ask you to do other things for me. For example, I might ask you not to use technology from a competitor country. I'm the U.S., and I might ask Europe to please limit the usage of 5G technology provided by Chinese firms. I might ask you to sanction some country. I might ask you to don't buy oil from Russia. I have no power over you directly. I'm the U.S. I can't ask a European firm or a European government to do anything. You're not a domestic firm.

Maggiori: This isn't a typical case of, I have, in some sense, a gist of the power over you. Here, I'm offering you something in return. I'm telling you that should you not do that, I will use the stick. That's what gets me the power and gets you to do these things. In general, things like sanctions, quantity restrictions, tariffs, markup in goods, show up as essentially optimal outcomes, at least from the perspective of the hegemon, of how I exercise my power. Linking to, particularly, the debates in the general public or in political science, one of the things that was interesting to us is the idea of whether this power is a zero-sum game or a positive-sum game, globally. It's much more natural or much more immediate to think of it as zero-sum because I have power over you, you give me something, and that's a transfer. But that's only one part of it, and I would say, actually, it's not probably the most important. I want to think more generally of there is something positive about having these big powers. There are many relationships across countries that can't be enforced. You can't take these countries to court.

Maggiori: And so having these big countries that act as global police help make tons of things happen around the world. Some of them are positive. Think about building infrastructure in Africa. It's a great thing to do it. Nobody wants to do it because it will get expropriated, but the U.S. or China might be able to do it, and that's positive. The problem is, of course, once they have the power, they will exert it to get things for themselves. That's a negative sum, that some of the things that they will obtain in equilibrium are not necessarily good for the world. They're good for them. The simplest example is markups. They're just distortionary, but, of course, the countries love them. They get to make money out of this.

Beckworth: Jesse, you want to add anything to that?

Schreger: I think that, related to that, the thing that really jumped out to us when we were thinking about, do hegemons make countries around the world better or worse? I think there's the sense of, when we think of economic coercion or using these threats to withdraw economic activity, there's the sense that, of course, the countries who are being coerced would necessarily be worse off. Fundamentally, in an area where countries are unable to credibly promise a future action, there's a big benefit towards being able to effectively tie your hands going forward. Fundamentally, this idea that, if the U.S. or China is able to say, there's two activities, one of which you're tempted to walk away on me from, as Matteo said, one instance would be sovereign debt.

Schreger: You're very tempted to walk away in sovereign debt. All you want to be able to do is promise that I'm going to make it much more painful for myself if I walk away from this debt contract. It's actually only the hegemons that are able to offer you this powerful commitment device of, well, if you walk away from me in one arena, I'm also the provider of the goods and services that you need in other arenas. Even though we often see, ex post, if countries are actually being economically coerced, of course, it looks as if they're going to be worse off. What we tend to not think about is the range of economic activities that are made possible by the fact that the power that hegemons have of exerting their influence across multiple economic activities, essentially opens up the range of activities that are possible to other countries around the world.

Beckworth: The global hegemon solves market failures. That's what you're saying. You're not able to enforce the contract, but they can through these multiple channels… the big stick, I think you called it. One example that comes to mind and maybe, correct me if I'm wrong here, but I think of the US, it has this massive military, it goes around the world, has bases around the world. Domestically, we decry the amount of money spent on it, foreigners don't like it. But the flip side, the benefits, I guess, you could say, that maybe we don't think about as carefully, is that maybe it preserves peace. It's a cost that we're bearing for the world, and in return, we're going to use that sometime to our advantage.

The Value of Commercial vs. Military Threats

Maggiori: I think there's an element of that, which is common, but here, I guess, the threats are much more commercial, and I would argue they're less expensive. Military usage is an extremely expensive enforcement technology. Countries very often use this middle ground, which are the trade and financial relationships. I think a very good example is the reaction to the Russian invasion of Ukraine. That's a terrible act. You would like to put pressure on the country not to do it. Now of course, you could use the military, but there are many reasons why that's a horrible option and a very expensive one, and so you try to resort to this middle ground, and it has limited power.

Maggiori: One thing that, in the paper, we try to do, is we try to clarify, when does power even exist and what are its limitations? One very obvious one is, there are alternatives. I can threaten to shut you off from a particular activity, but that threat only has any value in equilibrium. If that's expensive for you, if you can go to the next guy and to the next supplier and just ignore me, that's not very valuable. One of the things that we wanted to do with these big topics is reduce them to something that you can be precise on, why is there any power? Where does it come from? What are all of the many situations where, actually, you get no power whatsoever? And so also be realistic on, what can you ask in return? Jesse mentioned this. Here, one of the things that is special compared to domestic policy is, you're often asking actions out of governments and firms that you don't control. They're in other countries. You have to offer them something, and expensive actions that you can ask them to take on your behalf are limited by the value that you create for them.

Maggiori: You can't ask them to do all sorts of things because at some point they'll decide to walk away from you. They'll just ignore you. And so it really defines both the source of the power, but also the extent to which you have power, which is very different over a domestic firm where, in principle, you could legislate whatever you want if you're the US government. There are limits even there, but there's a much more direct enforcement technology. When you're asking a European firm not to use a 5G technology from China, they're going to be upset. That technology is profitable. They're only willing to do it in return for something else. What you can offer puts a bound on, in some sense, the extent to which you have power.

Beckworth: As you just noted, the hegemon has to offer something of value, some benefit to its partner countries, or otherwise they may walk away. In the case of the United States, it's interesting to look back at 2015, 2017, when we made this arrangement with our European partners to open up Iran, to drop sanctions if Iran agreed to dial back on its nuclear program. We reached this agreement in 2015, and as a result, European firms and banks began to engage with Iran. Then 2017 comes along and President Trump says, "Nope, the deal is off." This ticked off a lot of European partners because the US had this hegemonic ability to turn off the switch.

Beckworth: Fast forward to the Russian invasion and the US has this hegemonic ability to turn on and turn off the switch, and the Europeans loved it. In this case, we could place restrictions on Russia, its foreign exchange reserves, over 600 billion, and we're able to freeze it. It was a multilateral effort, not all the reserves were in dollars, but the US took the lead and other countries followed. At one point, the Europeans were ticked off about the hegemonic power, but then they saw the benefit later with the Russian invasion. So this is a case where, maybe, it took some time to appreciate and see the benefits of the hegemonic power.

Schreger: In understanding what the US effectively did with actions that eventually led European banks and firms to cut off Iran, I think that's the sense in which you could see what it means to exert hegemonic power in that, if you're Deutsche Bank or another German bank, and you're basically contemplating… the United States has walked out of the Iranian nuclear deal, your own government is basically critical of the United States. The situation you find yourself in is, you may be earning some positive profits from your engagement with Iran, but the profits that you earn around the entire world are dependent on you maintaining a satisfactory relationship with the United States.

Schreger: In some sense, we would understand this as, yes, Deutsche Bank would earn some profits with Iran, but the surplus that it has in its relationship with the United States is so large and it has so much to lose from being cut off from all aspects of the US financial system that when the US essentially makes the request of, take the costly action to cut Iran out of the global financial system, even though the national, Deutsche Bank's home government, would essentially disagree with the action, when you face a firm with the incentive, do I deviate from the US and lose all of the profits that are dependent on access to the United States, versus maintaining the profits in Iran, that's precisely what we mean, that you can ask another firm to take a costly action that is in the hegemon's interest. That's how we understand it through the lens of the framework we're putting forward.

Beckworth: How does one become a hegemon? What are the steps, the process, that a hegemon would emerge in the world?

The Key Elements of a Global Hegemon

Schreger: I think the key part of being a hegemon in our framework is essentially having dominance in not just one market of goods, but across multiple domains. The power to essentially join together, intermediating inputs, finance, large market, all of these disparate actions, it's going to be on different dimensions that countries find themselves most constrained. So the key is when you're able to exert influence across multiple areas, that's where the threat of cutting off a relationship with you carries the most downside for a country. That's where you're essentially going to be able to request that they take actions that they might find more personally costly. The ability to control one strategic input will, of course, get you somewhere, but it's really this ability to combine across multiple domains that's going to allow, you can call it coercion or the exertion of geoeconomic power, much more strongly.

Beckworth: Let's wrap up the discussion of your framework and we'll move to an example, but you have three key parts, and we've touched on them, input-output linkages, limited contract enforceability, externalities. Those are all key elements to understanding this phenomenon, correct?

Maggiori: Yes, I will talk a little bit about the externalities because we haven't mentioned it so much, and I find it really crucial to think about, both the inefficiencies that arise from a geoeconomic power, but also, for example, anti-coercion policy. The way I think about this is that there are many situations where, for example, we have thick market externalities. Let me make the example of 5G technology. I like to use it because you and Jesse are on the same technology and we're very compatible. Suppose that the US perceives a particular technology offered by the Chinese as a national security problem. It would like to ask the rest of the world, and maybe particularly Western Europe, not to use that technology. Now, that externality, it's pretty key. Why? Well when the US approaches the British and says, "We would like you to not use this technology," they perceive it as very costly because, again, the technology is profitable.

Maggiori: Then the US, at the same time, approaches German firms, the Italian government, some entities in Spain, asking for the same thing. Now you can see that, as you convince any one of them to stay away from it, it makes it easier to convince anybody else. Why? Because the British don't really value the technology if they know that the Germans and the Spanish are not on it. The same goes for the Italians. That's a typical example of, you want to exert more power in these sectors because, really, being big and contracting with many parties at the same time helps you. It's also clear, if you flip the argument, that convincing each of the parties involved, each of them only looks at their private costs.

Maggiori: If I ask a British firm not to use this technology, they're going to perceive it as expensive, taking everybody else as given, and so do the French and the Germans. As a hegemon, you're instead taking into account changing the entire equilibrium. You tend to exert more power in these circumstances because you're really playing with the fact that each of the agents, or each of the people you contract with, is only thinking about themselves and the cost to them, but you're perceiving the benefit, as a hegemon, from changing the entire equilibrium. If there are these externalities, the surplus can be much bigger than what the private cost is perceived from each of them. It also tells you, for example, if you flip the argument to the U.S. and China, imagine Eastern seaboard ports of the U.S. contracting with China. Now, each of them might accept a contract that, for example, gives China some power over the port, thinking only that there might be some cost to the local area doing this, but they're taking national security of the U.S. as given.

Maggiori: But the government might feel very differently, because it might think that China is approaching every port on the Eastern seaboard with that contract. If all of them accept having China control the entire Eastern seaboard of the U.S., that's a whole different game than one of the ports. And so these externalities are really crucial in this setup, both in telling you that the hegemons target those sectors, they have a reason to specifically focus on sectors that have these externalities, but also in telling you why we might want to have government intervention on the defensive side saying, "Look, when some of these contracts go through, we have to have government review,” for example. Because the private parties aren't thinking about what's happening in the overall country or the overall global equilibrium.

Beckworth: Okay, so that's the description of the framework. We've talked about, what is a hegemon, its ability to influence all of these different domains, touched on these areas that you've laid out. And we've given two examples, we'll come back to those in a minute. China and the U.S. are examples of hegemons. Are there any other regions or countries of the world that you would classify as a hegemon, has the ability to play that role beyond China and the U.S.?

Maggiori: I would say that, locally, there are clearly other examples. Some of them, particularly going back in time, are today's heritage of the colonial system. France clearly has an area of influence over North Africa that comes from the colonial era. I would also say that, in general, some of these attributes show up even in firms, not just in governments. Large tech firms might have elements of this power when they negotiate, for example, with smaller countries, or with entities that are dispersed around several countries in the world. Certainly, when you look at the scale of the U.S. and China, that's clearly very impressive and probably more obvious, but elements of this power show up locally in many different circumstances, even in the private sector.

Beckworth: Let's go to the examples you outlined in your paper. You start with the United States, Huawei, and the 5G, and the national security concerns. How does that fit this framework that you've outlined in the paper?

The US, Huawei, and 5G: Addressing National Security Concerns

Schreger: Great, so, this is building on what Matteo was talking about here. When Huawei was considering, or was trying very hard, a Chinese tech firm, to sell 5G technology around the world, while the U.S. reacted very strongly towards the technology not entering the United States, the goal of U.S. policymakers was essentially to encourage U.S. allies also not to adopt it. There was a deep concern, effectively, that if China had control, or a Chinese firm had control of the telecommunications system, that would be something that would show up as a national security risk for the United States. Now, the challenge was, within the United States, you could do this, essentially, by pronouncement, but how do you actually persuade allies around the world to do this? So when the United States began doing this at first, the UK was very reluctant to cut off relations with Huawei.

Schreger: There's a sense in which, because the U.S. had these very positive and crucial relationships with many firms in Western Europe, they were effectively able to convince a subset of firms and a subset of sectors within Western Europe to not adopt 5G technology. And because there are these network effects, what Matteo was calling the thick market externalities, that subsequently made it less appealing for every other country to adopt it. And so that was the sense in which the United States didn't have to compensate. You would have to compensate any individual firm for the private loss that they would have from adopting an alternate telecommunications, rather than Huawei's 5G, but you don't actually have to compensate every firm for the externality part. The fact that if a country or a firm stopped using it, the fact that it makes it less appealing to everybody else, the United States got to capture that surplus. And so while we would understand, yes, that was asking firms to take a privately costly action, there was still… even if the U.S. had to compensate for that action, there was still this large benefit that the U.S. could realize by essentially destroying the network effects that would have been available to this Chinese firm.

Beckworth: That's really interesting. The U.S. government is putting its thumb on the scale of what network is going to prevail. In this case, it's not going to be the Chinese firm. With that thinking, how would you approach the U.S. government's restrictions, for example, on computer chips and computer parts being sent to China? Is that more limited? Because I don't see, maybe, the network effects there, but are there some that maybe I'm missing?

Schreger: I think, more generally above the network effects here, I could understand it as direct note. When Matteo was talking about externalities, to make it explicit here, I think the U.S. has the view that as China gains capabilities in AI and other forms of high technology, that is something that directly strengthens the Chinese military. The U.S. would essentially perceive a stronger Chinese military as something that makes the U.S. less safe. The way we would really understand semiconductor restrictions as direct and aimed to directly make China less productive, in sectors where the U.S. perceives Chinese productivity, making the United States strictly worse off. This would be the case where the United States, I think, would perceive something closer to a zero-sum world.

Schreger: There's a sense in which, as the Chinese military is more powerful, the U.S. is, by definition, relatively less powerful. I think here we would think of semiconductors as more directly reducing the productivity of these industries that are key inputs into current military strength. The challenge, though, I think where it would come in, is you can actually see there's a limit to how much the United States can ask individual firms and its allies to actually undertake these policies. Why is the United States able to ask certain firms to actually restrict exports to China? It's this sense that there's more of a surplus and more of a reliance on the United States than there is with China. You see this in the constant debates and announcements with, say, NVIDIA. It seems that the U.S. can restrict some level of NVIDIA sales to China, but there is always this question of, if you make it completely unprofitable for NVIDIA, you lose the entire market there. There's a sense in which then you're asking more than the surplus that the company has with the United States.

Schreger: And so, in the context of how you can exert geoeconomic strength to actually achieve this goal, I think that what the U.S. is trying to find the balance of is, how much can you actually ask private firms to cut their profits by selling to China? We would say that the most you can ask of a private firm is the surplus that you get from interacting with the U.S. That is the most you can credibly threaten without a firm saying, “You know what? I would rather do business primarily with China,” which is what the U.S. would certainly not want. You still want to have it that these firms prefer to keep their market share while cutting the sales to China.

Beckworth: Let me throw out another China example. It's not in your paper, but it comes to mind, and that is the influence that China has had on the entertainment industry. For example, what movies they can say, if Disney will change a certain part of the movie so it doesn't offend the Chinese, or advertisements are very careful in what they market overseas. Movies might be catered to the large China audiences. In fact, the movie market that, I believe, is the largest in the world, is in China. Does that have any relation to this, or is that just a separate issue?

Schreger: No, I think that fits in there directly. There's a sense in which, fundamentally, China doesn't even have to say what it wants in order for firms to go along with it. Fundamentally, if you know that, if you are selling a product to China, and you take certain political positions, then you will lose access to the Chinese market. Therefore, it is this threat that, if you deviate in a certain way, you will lose this realm of your profits. I think you saw that-- in our framework, basically, firms will tend to go along with this threat. Essentially, the threat will prevent this deviation. Of course, in reality, you'll actually see some, what we call on-path deviations. To me, the most striking one was when Daryl Morey, of the Houston Rockets and the NBA, criticized Hong Kong. In some sense, you could see that there was, effectively, this implicit agreement that NBA games were going to have access to China on the condition that certain political issues not be broached. You could almost see that, how can this market access be used to shape firm behavior? It is this credible threat that if you take a certain action, those profits are going to go away.

Beckworth: Yes, I remember that very well. I remember certain prominent players like LeBron James being very vocal about social justice issues, except when it came to China. They were very quiet and they said, "We don't agree with this individual." Let's go to the China Belt and Road Initiative. How does that help us understand your framework?

The China Belt and Road Initiative

Schreger: At least for us, starting in international macroeconomics, there's been this question of, why do governments ever repay their debt? This goes back to the seminal work of Bulow and Rogoff, this idea that what's different between a government and a firm is the fact that if a firm wanted to walk away from its debt, what do you do? You fire all of the executives, the equity price goes to zero, and you can seize some of the assets. Fundamentally, the reason why you repay sovereign debt has to come down with some sort of external cost. In the absence of an external cost, we would believe that it's so tempting for governments to walk away, that you actually can't borrow anything at all. More recently, there's been work on so-called debt intolerance, so Reinhart, Rogoff, and Savastano. It's this remarkable finding that developing countries tend to default on their sovereign debt, stop paying at very low levels of debt-to-GDP.

Schreger: We're talking in the 10% to 15% of GDP range. How does this relate to the Belt and Road? What's remarkable right now is that you actually see huge amounts of debt, sometimes up to 100% of debt-to-GDP, owed by very poor countries. While you might see those levels of debt in the rich world, you very rarely saw those in developing countries, previously. They used to default at far lower levels. How are we going to understand what China is really doing with the Belt and Road? This is the trillion-dollar-plus infrastructure spending program abroad. We would really understand that developing countries around the world fundamentally wanted to import capital in order to build large development projects.

Schreger: What was the constraint on their ability to do so? That in the space of sovereign debt, you can't actually promise to repay. Lenders know that you can't promise to repay, and therefore, they don't lend. What would you really like to be able to do? You would like to be able to tie your hands and promise that you're going to repay the debt. Of course, any contractual promise isn't going to be that valuable because you can't directly sanction a sovereign. So, how do we understand the Belt and Road? How did China pursue this?

Schreger: China is effectively lending for projects like infrastructure, but along with this infrastructure finance, comes an agreement to purchase the supplies and often actually hire Chinese contractors to implement this. So, if you're undertaking a large infrastructure project, and you know that if I default on the debt side of this contract, I actually lose the ability to complete the project itself, because I've sourced from the same countries, all of a sudden, I'm much less tempted to walk away from my infrastructure spending. And so, because countries were basically so eager to undertake these large-scale infrastructure projects, they put a lot of value on this finance. That means that China, not only offering the debt finance to do this but also, essentially, the commitment tool of the threat to withdraw the intermediates in order to actually build these goods, essentially makes this a very appealing deal for countries.

Schreger: And so that leaves the ability for China to essentially ask for other things. Now, these other things could show up in multiple ways. Maybe loans would look like they are subsidized. Maybe they'd look like they're concessionary, but because it's going to be packaged with intermediates, if you're paying a lot to Chinese construction firms or Chinese manufacturers for the imported goods, China could still be making profits on the package. As an addition, the ask may be non-economic. One thing that comes out very clearly, and actually this is drawing on some fantastic work of Bradley Parks and the AidData team, as well as the work of Carmen Reinhart and Cristoph Trebesch, that really led putting together data on the Belt and Road, it's this finding that when China lends to a country for the Belt and Road, one of the strongest predictors of whether or not you're going to get a lot of Belt and Road lending from China is whether or not you recognize Taiwan.

Schreger: If you are going to have a Taiwanese consulate, you can effectively guarantee that you're not going to be getting this development lending. That's the sense in which the lending might look cheap, the intermediates might look cheap, but if China is able to get this non-economic benefit, countries will be happy because they're getting this infrastructure finance they couldn't get, and China may be happy because even if the finance is subsidized, they might actually be getting these non-economic or political benefits that they've been searching for.

Beckworth: Very interesting. Let me throw out one more example. I'm going to go back to Daniel McDowell, I mentioned him earlier. His book is Bucking the Buck, and the subtitle is, U.S. Financial Sanctions and the International Backlash Against the Dollar. The point of his book is that the U.S. has been increasingly exercising financial sanctions, really since after 9/11, because the dollar is everywhere, invoices, its usage, SWIFT, a good portion of it is done in dollars, international clearing. For all of these reasons, the U.S. Treasury, the OFAC office, can go and list people, can put them out of commission in the international dollar payment system. We've gone after countries that would be obvious, like North Korea. We've gone after Iran, I mentioned, Libya, but more recently, Russia.

Beckworth: He even highlights the case of Turkey. Turkey is a NATO ally, and we imposed sanctions in 2017 on them, just a few people, not the whole country. Then more recently, this year, we imposed sanctions on them because they were letting some shipments from Russia get by. The point of his book is, are we overusing financial sanctions? I bring this up because, is it possible for a hegemon to overuse its authority, its power, overuse that big stick? Could that big stick become shorter and smaller if it's not careful?

Can a Hegemon Overuse its Power?

Schreger: First of all, I think that that book is fantastic. Let me tell you a little bit about how I think of the role of the dollar in sanctions. When you think about what makes the source of the U.S. dollar being the center of the international monetary system, I really think of it as coming down to what it means to be the safe asset provider, which is the idea that in every state of the world, you can turn those pieces of paper into goods and services that you need. In the early 2000s, it looked like Europe would be on track to compete with the dollar, but with the European sovereign debt crisis, you could start to see that there are events that happen such that I'm actually not able to turn euros into the things that I would need, unconditionally.

Schreger: Now, with what the U.S. has been doing more recently with sanctions, I think that, what you can understand the risk the U.S. is taking, is that the dollar is no longer a safe asset from the perspective of every country. It's a bilaterally safe asset. If you are a U.S. adversary and you own U.S. Treasuries, which is just a promise of the United States to repay you, you can now imagine that there are states of the world in times when owning those U.S. Treasuries no longer actually can be turned into goods and services that you may value. And so, this is something that the U.S. was very reluctant to do, because I think that there's a meaningful sense in that you can understand that freezing Russia's reserves, or before that, seizing the reserves that were held by the Afghan government that then became the Taliban with the takeover of the country, what that fundamentally means is that the United States is not going to pay that debt bilaterally.

Schreger: And so now countries have to think, in what states of the world is owning U.S. Treasuries not going to be valuable for me. And so when you think of the alternatives to the U.S. dollar, one of the things you have to think about is, if you're buying insurance against the U.S., you want to have an asset that pays off in precisely the times when the U.S. is not going to give you your money. What we saw with the sanctioning of Russia recently is, with the ECB and the Euro area also sanctioning Russia and even Switzerland going along with this, if you're contemplating alternatives to the U.S. dollar, and what you're really concerned about are those times that the U.S. essentially-- you've crossed the U.S. geopolitically, and therefore you're not going to be repaid, you're looking for an asset that pays off precisely when the U.S. dollar is not valuable to you, even if it's valuable to everybody else.

Schreger: That's where I think it's the primary reason why countries may want to hold some reserves in Chinese renminbi, because there are plenty of reasons to not hold Chinese renminbi. I think China has a long way to go to essentially build a reputation for convincing foreigners that they can actually get money in and out of the country freely. In terms of being a safe asset, if you're not certain whether you can get renminbi out and convert it into things you need, then it can't be a safe asset. What can China really offer? It can very credibly offer that, in times of the world when the United States is very mad at you, they're probably not. That's the sense in which even if the renminbi would be costly, it would be offering something that looks a lot like insurance for the U.S. dollar because it should be able to pay off when, geopolitically for a U.S. adversary, the dollar does not pay off.

Beckworth: Do you think China will ever be willing to provide enough financial liabilities to the world, such that there's enough to meet this demand? One question I would have is, okay, so you don't want to be susceptible to the whims of the U.S. government, but what are the alternative assets? China would be one, but China, their strategy is to run trade surpluses. They would have to run trade deficits to get these financial assets out to the world. They'd have to get them widely held, widely used. As you mentioned, they have capital controls, issues about rule of law. Is there really, I guess, a viable option? Yes, China theoretically plays that role, but can they provide enough alternative safe assets to meet the world's demand?

Could Other Hegemons Challenge the Global Dollar System?

Maggiori: That's a great question, so let me take it in two parts. The first is the idea that this has got to do with the net. Generally, I'm not a fan of that idea. Very often in the media, you hear the argument that in order to be a provider of an international currency, you have to run a trade deficit. It's almost phrased in terms of just giving currencies to the foreigners. I think that one is just not correct in either theory or practice. From the practice, England was the cornerstone of world markets for many years while running a gigantic current account surplus. From a theory perspective, why is it not correct? Because it's mixing up the net with the gross. What you have to do is certainly provide a store of value, which means you have to let the foreigners save and save safe bonds in your currency.

Maggiori: But now you have two options. You could consume, then that's net borrowing, or you could reinvest it abroad, presumably in higher-yielding risky assets. That's the world banker view of a reserve currency. Now, in general, why do you do it? Well, precisely because you make more on the assets than you pay on the liabilities. There is an expectation, a stream of revenue that you make, out of running this world bank. That one is what pushes you towards a deficit. Now, what is that? It's like running a huge hedge fund or a bank. You're going to make money, on average, that lifts up your consumption, and, therefore, you go towards more of a deficit or less of a current account surplus. But this statement is really on the margin. All else equal, if you were running a huge current account surplus, now you will run a slightly smaller one.

Maggiori: So, I think that that's quite important because it clears up, I think, a confusion on the net versus gross that I think is crucial in assessing what it takes to be an international currency. Now, the second part of your question is instead of… okay, but even then, running a large bank or a large hedge fund isn't easy. It needs to be credible. In particular, what am I doing? I am telling you that you can deposit with me in short-term bonds in my currency. It means that I will not depreciate on you, I will not default on you, and I will not impose ex post capital controls of financial repression. And those are very difficult promises to make credible because everybody understands that, ex post, when the crises come, I might not want to maintain those promises.

Maggiori: In the confines of China, one very obvious one is the capital controls. Everybody knows that you can now bring money into China, bond connects, stock connects, or programs that allow you to do that. But the big question is, if there were a huge crisis and you wanted to get your money out, could you get it out freely? Second, as Jesse said, is that ability differential depending on whether you're a close political ally or not? Even if I sidestep the issue of political alignment, that's going to be a big worry. For China itself, that's a big worry. Why? Because, well, sudden stops in capital flights are expensive. China is experiencing one right now. They had originally, since 2017, allowed more and more foreign private investors to access the onshore markets in China. Given the political tensions and the slowdown in the Chinese economy, a lot of that capital is flying out.

Maggiori: So far, China has simply let it come out. Now, that's not that expensive. Foreigners were something like 4% or 5% at the height of the Chinese bond market, so even a 50% capital flight isn't that expensive. But imagine that we had gone much further along in the liberalization program, and foreigners were 20% of the Chinese bond market. Now, that's an expensive capital flight. It might trigger a domestic financial crisis and fire sale, and countries like the United States have a stellar reputation for a reason. Even during the 2008 crisis, the U.S. never dreamt of imposing capital controls. If you wanted to liquidate Treasuries because you needed them, you could. You asked the question of overusing the sanctions, the U.S. government is very conscious of this, and it's trying to frame the sanctions very narrowly.

Maggiori: It's trying to say, "Look, unless you're Russian and you're invading a peaceful country, you shouldn't be worried about us sanctioning you." Now, other countries might worry that they might be next on that list. I interpret those statements as saying, "You shouldn't worry unless you're going to give us reasons to act on you." That's precisely to avoid eroding the centrality of the dollar, that you don't want to make it sound like you're going to impose sanctions for all sorts of reasons.

Beckworth: Matteo, let me go back to your paper with the late Emmanuel Fari, *A Model of the International Monetary System.* I want to again invoke this Nurkse instability idea that if you have multiple monetary hegemons, you could actually be less stable than if you had just one. Does that tie into this current work on geoeconomics?

Maggiori: Yes, some elements of it are here. Clearly, the big thing in our current work is the existence of an alternative. In some sense, how much power that I get over you with the threats has to do with the relationships we currently have? Think of, like, substitutability from a production perspective. Semiconductors are a very good thing to threaten you with because it's extremely difficult to manufacture them at scale somewhere else. If I control two or three of the big foundries or rare earths or something like that… you know, water isn't. If you don't get water from me, you can get it from somebody else. Then there is also the idea at the country level that I might want to join the network of an existing hegemon. But if they try to over-abuse me, I might start looking for an alternative.

Maggiori: For example, I might start playing China and the US-- I'm a small country and I might look to play China and the US against each other to extract surplus. This is something that we're actively working on. You might be tempted to think of the idea of the existence of an alternative as just simply good, because it limits the ability of one of the countries to exert power and extract the revenues. But again, there is something positive about that. And so, that might also end up with a worse equilibrium. I'll give you a concrete example. Sanctions on Russia on oil aren't that effective if the Chinese and India are buyers. They are two very large countries that can absorb a lot of the oil. The fact that these countries can provide an alternative might have been undesirable from a global perspective, because we would have wanted to exert more pressure on Russia to stop using its military to invade Ukraine.

Maggiori: But that, now, isn't that effective. And so, you really have to think about this power as having both positive elements for the world and negative elements in terms of the extraction. In that context, the presence of an alternative can cut both ways on whether you're strictly better off or not. The argument is fundamentally different from the Nurkse argument that had to do with coordination in the monetary system, but it has an element of, competition or the presence of an alternative isn't always good once you have commitment and enforcement problems. It's much more obviously good if you go to a simple frictionless model.

Beckworth: In the time we have left, what are your thoughts about the future of the research agenda for geoeconomics? Do you see this being something people are interested in, they're picking up? Where do you hope it will go?

The Future of Geoeconomics

Schreger: I obviously hope that this field grows, because I think it's really capturing one of the key features of the international monetary and financial system. This is one of the defining questions of today. So, what I'm really hoping for is that we start to see empirical work along with an increase in theory here. As we started working on this, what really jumped out to us is how many of the core questions in the area we really didn't have a systematic knowledge of. One of the types of things we're working on is, we know that states are playing an increasing role in the international financial system, but a systematic understanding of what precisely states have acquired around the world, whether firms owned by states are behaving differently, how states differ from the private sector in acquiring what they deem strategic industries, I think that, right now, there's a major opportunity to try to add an empirical understanding of these questions. And so, I'm really looking for an explosion of research in that area.

Maggiori: I'm mostly interested, also, in the policy side. I'll do an analogy with the macroprudential literature, or in general, the literature surrounding financial regulation. If I look 20 years back, the debate was a little bit stuck at the extreme of, either financial markets are perfect and there's nothing to do, or at the other end as if we wanted every loan of the United States to be made by the government and the government could pick exactly who the right borrowers are and all of that. I feel that sometimes the debates surrounding geoeconomics remind me of that. There is the one extreme of, everything is perfect, the government should never be involved, and we go to free trade and nothing else, which I think doesn't recognize enough the idea that lots of these issues are among countries where there's no enforceability, there's lots of frictions.

Maggiori: On the other extreme, there is the simplistic view that government should do all sorts of actions which should return to protectionism and industrial policy where countries pick winners, which has had a disastrous history. I think, very much, in the financial literature on regulation, we have to start characterizing what are the inefficiencies? What is that all for the government? What should be optimal instruments? In a second-best world, who should be controlling them? In some sense, narrow the debate to the area where, really, we can add some value. I see lots of countries, including the European Union, that are developing anti-coercion policies, but I don't know what the foundations for the policies are. What are we solving, who's controlling the instruments, what should the instruments be?

Maggiori: We're at the very beginning of this process, I have more questions than I have answers, but my hope is that, with economic theory, also borrowing and relating to the political scientists with empirical work, 10 years from now, we might be in a position where we really brought the debate away from the extremes and into the middle, where you're actually recognizing lots of the benefits of free trade and free finance, and then at the same time, smoothing the edges and learning that there are instruments that can make the world better off. I think if you're a small country in Africa, and China is approaching you, telling you that we should go for free trade doesn't seem like very useful advice. On the other end, I am worried that the US is using a lot of the rhetoric or the words that we've used to justify all sorts of protectionist policies, which I doubt will be very useful. I think there's a long history of those not working. It's somewhere in the middle where I think we can really add value as economists, and I hope that the literature gets to do that and is successful.

Beckworth: Well, we'll have to check back in with you gentlemen in about a decade from now and see where the literature is. Hopefully, it's in that middle spot that you've described, Matteo. With that, our time is up. Our guests today have been Matteo Maggiori and Jesse Schreger. Matteo and Jesse, thank you so much for coming onto the show.

Schreger: Thanks so much for having us.

Maggiori: Thank you for having us, David. It was a pleasure.